How to Qualify for a Student Loan Tax Deduction When You Least Expect It

Generally, federal student loan borrowers who’ve taken advantage of the ongoing federal student loan payment and interest pause probably won’t get a Form 1098-E to claim the student loan interest tax deduction. 

However, if you have any private loans or federal loans that aren’t held by the Department of Education (such as commercially held Federal Family Education Loans or Perkins Loans), you’ve probably continued to pay interest through the pause as normal. 

Depending on your situation, there’s a chance you might still be eligible for this tax deduction during the 2023 tax filing year. Here’s what to know.

NOTE: This is generalized information and not intended as tax advice. Speak with a tax professional to determine the best tax strategy for your situation.

How the student loan interest tax deduction works

The student loan interest tax deduction is an above-the-line tax deduction that lets you deduct a maximum of $2,500 for paid student loan interest on your 2022 tax return. The deduction can be applied whether you’re taking the standard deduction or itemizing your return.

It’s an AGI deduction or an adjustment of your gross income. Unlike a tax credit, a deduction doesn’t directly affect your dollar-for-dollar tax liability. Instead, the deduction offsets the amount of income that’s used to calculate your tax liability which impacts the tax credits you qualify for and the amount of your tax refund. 

If you’ve paid more than $600 of interest with any one servicer during the year, you should receive an IRS Form 1098-E stating the amount of interest you paid. If you don't receive a 1098-E — or don’t feel it represents all interest paid — then you might still be eligible for the deduction, but must take a few additional steps.

Common Form 1098-E scenarios

If you paid $600 or more in interest over the course of the year towards private or federal student loans serviced by a single provider, servicers are required to report payments on IRS Form 1098-E by January 31, 2023.

Below are some different situations you might encounter regarding a 1098-E:

• You paid $600 or more in interest. If you satisfy the minimum interest paid to a single loan servicer, you’ll receive a 1098-E.
• You paid less than $600 in interest. If you paid less than $600 to your loan servicer, you won’t receive a 1098-E. However, you can visit your servicer’s website to get the exact amount of interest paid during the year.
• You paid $600 or more across multiple servicers. If you paid a combined $600 toward student loan interest, but it’s dispersed across more than one servicer, you likely won’t receive the 1098-E. You’ll need to defer to your servicer’s website or statements.
• You got a 1098-E from one, but not all, of your servicers. You’ll want to get the interest-paid amounts from your other servicers.

The 1098-E isn’t needed to file your taxes correctly and receive the deduction, but referencing it is much easier for tax filing. If you don’t receive one, but would otherwise qualify, you’ll want to take further steps.

Who qualifies for the student loan interest tax deduction?

Per IRS regulation, to qualify, you must: 

• Have paid interest on a qualified student loan in tax year 2022,
• Be legally obligated to pay interest on a qualified student loan,
• Not file as “married, filing separately” status,
• Have a MAGI that’s less than a specified amount which is set annually (included below),
• and neither you nor your spouse, if filing jointly, can be claimed as a dependent on someone else’s return.

A qualified student loan is:

• For you, your spouse, or a person who was your dependent (as defined later for this purpose) when you took out the loan;
• Paid or incurred within a reasonable period of time before or after you took out the loan; and
• For education expenses during an academic period for an eligible student.

A qualified loan is not a loan by a related person, or from your qualified employer retirement plan.

Although the loan requirements are straightforward, unfortunately there are income limits for qualification and the deduction amount available. The brackets are based on Modified Adjusted Gross Income (MAGI). If exceeded, it begins phasing out for a partial deduction up to excluding you from eligibility entirely if your MAGI is over the top of the bracket.

See amounts below, and note that your tax filing status also impacts the numbers and eligibility.

Within the phaseout, if your MAGI is in the ranges above, multiply your interest deduction (before the phaseout, but not more than $2,500) by a fraction. The numerator (top) is your MAGI minus $70,000 (or $145,000 in the case of a joint return). The denominator (bottom) is $15,000 (or $30,000 in the case of a joint return). Subtract the result from your deduction (before phaseout) to give you the amount eligible.

Example:

During 2022, let’s say you paid $2,500 in interest on a qualified student loan. Your 2022 MAGI is $150,000 and you’re married, filing a joint tax return. You must reduce $2,500 by $416.67, as shown below, to calculate a deduction of $2083.33:

$2,500 x [($150,000-$145,000)/$30,000)] = $416.67

What counts as “paid interest” for the deduction?

Student loan interest is the interest you pay during the year on a qualified student loan. It includes both voluntary and involuntary interest payments.

In addition to the stated interest on the loan, the items below can also be included as student loan interest for the purposes of the deduction:

• Loan origination fees. A loan origination fee must be for the use of money rather than for property or services (such as commitment fees or processing costs) provided by the lender. A loan origination fee treated as interest accrues over the life of the loan. If loan origination fees aren’t reported on your 1098-E,  use any reasonable method to allocate the loan origination fees over your loan term.
• Capitalized interest. This is outstanding interest that’s added by the lender to the outstanding principal loan balance. Capitalized interest is treated as paid interest for tax purposes and is deductible as interest payments are made on the loan. No deduction for capitalized interest is allowed in a year in which no loan payments were made.

Getting a student loan interest tax deduction for non-Department of Education federal loans

If your FFEL or Perkins loans only represent a portion of your loan portfolio, you’d presumably have paid less interest than before the pause. If your paid interest was under $600, or at that amount but not with any one servicer, you need to request how much you paid in interest.

To qualify for the recent waivers and federal payment pause, many borrowers are consolidating their federal loans that aren’t held by the Department of Education. They’re applying for a Direct Consolidation Loan to get their debt into the Direct Loan system through a Direct Loan Consolidation application due to the waivers and to qualify for the pause.

When you consolidate loans, you capitalize the outstanding interest. Since this counts as paid interest, it could be allocated against your principal payments. Let’s say your interest payments don’t total $2,500, but your total payments do. This would increase how much of the amount is counted as paid interest to maximize your deduction!

If you consolidated in 2022, some of our clients got 1098-E forms being issued with capitalized interest paid in the tens of thousands. As to whether it can be used toward your deduction even if you didn’t make payments on those loans, we’ll leave that up to your accountant.

The bottom line

Although maximizing your student loan interest deduction might be an unexpected perk, you wouldn’t want to consolidate your loans just for this reason. However, it’s another benefit if you’ve been considering a Direct Consolidation Loan to capitalize on the IDR waiver and one-time account adjustment. 

If you’re pursuing student loan forgiveness, either via Public Service Loan Forgiveness or Income-driven repayment plans, the waivers could save you much more than any tax benefit. Need help piecing together a student loan repayment strategy? Book a consultation with us today.